Rinehart rocks the Fairfax boat

Iron ore billionaire
Gina Rinehart
’s latest raid on Fairfax Media has put the company in play and raised doubts about whether the board’s preferred strategic direction for the company will be realised.

Rinehart, a prominent critic of
Fairfax
chairman
Roger Corbett
, showed her determination to influence the company’s direction by spending $25 million buying 42 million shares at 60¢ through Bell Potter Securities.

The intriguing aspect of this sharemarket raid was that the share price fell. That says the market has little confidence that Rinehart will make a full takeover bid for the company. People close to her say that is correct.

The fact that Fairfax shares fell 1¢ on the day a billionaire was buying stock tells you that the hedge funds and others who followed Rinehart into the market were unable to offload their stock to her.

The message from the sharemarket is that Rinehart wants the sort of influence a Fairfax directorship will bring but she does not want to spend another $1.2 billion taking full control of the company.

However, she may be able to get complete control of the most influential parts of the company, the metro group, if other shareholders back her and she falls into line with their plan for a Fairfax break-up.

Yesterday’s buying of stock lifted Rinehart’s shareholding in Fairfax to about 15 per cent and, in keeping with Australia’s accepted board room conventions, would entitle her to a board seat.

Rinehart has made it clear that she wants to buy enough stock to take her holding to the takeover threshold of 19.9 per cent. At that level of shareholding she could rightfully demand two board seats, given the company’s previous attitude to holders of that much stock.

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However, Corbett will only open the Fairfax boardroom position to Rinehart if she bows to the company’s long-standing corporate governance protocol which demands that directors commit not to interfere in editorial decisions.

It is clear that Corbett will not resile from this governance issue. He is taking a strong stand in the belief he has the support of major shareholders who see it as an critical issue for preserving the Fairfax brands.

Rinehart may decide to reject the Corbett demand and take the company on through the same sort of process used successfully by
James Packer
at
Echo Entertainment
. She could call an extraordinary general meeting and seek to sack existing directors and appoint her own preferred candidates.

This is essentially an attempt to get control of a company without paying a premium for control. It worked for media billionaire
Kerry Stokes
at
West Australian Newspapers
in 2009.

The apathy of shareholders usually plays into the hands of those pursuing this sort of strategy. Usually only about 40 per cent of shares on issue vote at extraordinary general meetings. That accentuates the voting power of someone with more than 20 per cent of the issued capital.

If Rinehart bought 19.9 per cent of the company and then used the creep provisions of the Corporations Law to buy 3 per cent of a company, she could be in a position to win an EGM vote by the end of the year.

A war between Rinehart and a Corbett-led Fairfax board would be very different to the recent battle for board seats at Echo Entertainment. In that case, several directors were sympathetic to Packer and forced out the Echo chairman, John Story.

It is unlikely that any of the directors of Fairfax, who have all committed to editorial independence, would suddenly turn on Corbett. Also, community loyalty towards Fairfax and its journalism could play a significant role in any power play for control.

That is not to say that Rinehart would not have support from existing shareholders.

This is where her ambition to have influence over the direction of Fairfax meshes with the demands of some Fairfax shareholders for the company to be broken up.

This break-up strategy has been floating around for about 12 months. The simplest step in the plan is to sell the company’s $600 million stake in New Zealand auction site Trade Me. Other assets in radio could be sold.

The most difficult step involves demerging Fairfax’s metro group, which includes The Sydney Morning Herald, The Age, The Sun Herald, The Australian Financial Review and the associated digital news and transactional businesses.

Proponents of the demerger claim it would remove the single biggest contributor to group costs and leave behind a company that was more profitable and less exposed to the structural issues facing newsprint.

The metro group contributes about 20 per cent to Fairfax’s total earnings. But it is under pressure from declining advertising revenue. That decline in revenue has accelerated this year, according to a market update issued last week.

The high cost base of the metro group, with its printing presses and large numbers of staff, mean that it is highly leveraged to a decline in revenue. An 8 per cent decline in revenue flows through as a 20 per cent decline in earnings.

Following last week’s update, media analysts have speculated that The Sydney Morning Herald and The Age are losing money. That has tended to add weight to the break-up argument but that ignores the benefits the metro group gets from centralised overheads as well as the potential costs of restructuring.

It is estimated that the cost of restructuring a stand-alone metro group would be at least $300 million. You can add to that the demerger fees for bankers, lawyers and others of about $50 million. This option is too expensive to contemplate unless someone like Rinehart is willing to take on these expenses and take control of metro group.

A break-up plan would also trigger a complex and extremely costly restructuring of the company’s $1.1 billion in net debt. Fairfax currently has a very favourable debt package which includes a mix of bank debt, eurobonds and US notes.

The $550 million in eurobonds are due to be repaid soon. But cash held for the purpose of repaying debt will leave the balance sheet, which means the net debt will remain the same at $1.1 billion.

Restructuring the Fairfax debt could see the interest margin paid to the banks double and trigger bank fees of $20 million to $30 million because of changes to covenants.

The metro group could not carry any debt, which would mean keeping the Fairfax debt load on the regional newspaper assets. But the regional newspapers, while defensive, could not sustain debt of $1 billion.

The board is proceeding with its plan, labelled “Fairfax of the Future", which involves restructuring the metro group using the existing cash flows. It takes the view that we are in a period of cyclical and structural change but a right-sized company will deliver increased profits when the cycle turns.